##### Table of Contents



U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


Form 10-Q



|[X] |  | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
|--- |  | ---------------------------------------------------------------------------------

For the quarterly period ended September 30, 2002.



|[  ] |  | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
|---- |  | ----------------------------------------------------------------------------------

For the transition period from _____________to ______________.

Commission file number _________

EXCHANGE APPLICATIONS, INC.

(Exact name of registrant, as specified in its charter)


|                                                                        |  |                                                
|----------------------------------------------------------------------- |  | -----------------------------------------------
|Delaware
(State or other jurisdiction of
incorporation or organization) |  | 04-3338916
(I.R.S. Employer
Identification No.)

89 South Street, Boston, Massachusetts 02111
(Address of principal executive offices) (Zip Code)

Registrants telephone number, including area code 617-737-2244



---

(Former name, former address and former fiscal year, if changed since last report)


Check whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the
past 90 days.

Yes [X]       No [  ]

State the number of shares outstanding of the registrants common stock, as of
the latest practicable date.

|                            |  |                                     
|--------------------------- |  | ------------------------------------
|Number of Shares: 1,152,892 |  | Outstanding as of: November 13, 2002





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TABLE OF CONTENTS



|                                                  |                                                                                                |                                                      |  |  |  |  |  | 
|------------------------------------------------- | ---------------------------------------------------------------------------------------------- | ---------------------------------------------------- |  |  |  |  |  | 
|PART I    FINANCIAL INFORMATION                 
|                                                  | ITEM 1. Financial Statements                                                                  
|                                                  |                                                                                                | CONDENSED CONSOLIDATED BALANCE SHEETS               
|                                                  |                                                                                                | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS     
|                                                  |                                                                                                | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                                                  |                                                                                                | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|                                                  | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
|                                                  | ITEM 3. Quantitative and Qualitative Disclosure about Market Risk                             
|                                                  | ITEM 4. Controls and Procedures                                                               
|Part II  Other Information                      
|                                                  | Item 1. Legal Proceedings                                                                     
|                                                  | Item 3. Defaults Upon Subordinated Notes                                                      
|                                                  | Item 4. Submission of Matters to a Vote of Security Holders                                   
|                                                  | Item 6. Exhibits and Reports on Form 8-K.                                                     
|SIGNATURES                                       
|CERTIFICATIONS                                   
|Ex-99.08 Certification of Chief Executive Officer



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##### Table of Contents



Exchange Applications, Inc.

Form 10-Q for the Three Months Ended September 30, 2002

Table of Contents

PART I. FINANCIAL INFORMATION

|                           |  |                                                                                      |  |                                                                                                                 |    |  |             |  | 
|-------------------------- |  | ------------------------------------------------------------------------------------ |  | --------------------------------------------------------------------------------------------------------------- | -- |  | ----------- |  | 
|                           |  |                                                                                      |  |                                                                                                                 |    |  | Page Number
|                           |  |                                                                                      |  |                                                                                                                 |    |  |            
|Item 1.                    |  | Financial Statements (unaudited):                                                    |  |                                                                                                                 | 3  | 
|                          
|                          
|                          
|                          
|                           |  |                                                                                      |  | Condensed Consolidated Balance Sheets as of December 31,
2001 and September 30, 2002                            |    |  | 3           | 
|                          
|                          
|                          
|                          
|                           |  |                                                                                      |  | Condensed Consolidated Statements of Operations for the
three and nine months ended September 30, 2001 and 2002 |    |  | 4           | 
|                          
|                          
|                          
|                          
|                           |  |                                                                                      |  | Condensed Consolidated Statements of Cash Flows for the
nine months ended September 30, 2001 and 2002           |    |  | 5           | 
|                          
|                          
|                          
|                          
|                           |  |                                                                                      |  | Notes to Condensed Consolidated Financial Statements                                                            |    |  | 6           | 
|                          
|                          
|                          
|                          
|Item 2.                    |  | Managements Discussion and Analysis of Financial
Condition and Results of Operation |  |                                                                                                                 | 10 | 
|                          
|                          
|                          
|                          
|Item 3.                    |  | Quantitative and Qualitative Disclosure about Market Risk                            |  |                                                                                                                 | 19 | 
|                          
|                          
|                          
|                          
|Item 4.                    |  | Controls and Procedures                                                              |  |                                                                                                                 | 19 | 
|                          
|                          
|                          
|                          
|PART II. OTHER INFORMATION
|                          
|                          
|                          
|                          
|Item 1.                    |  | Legal Proceedings                                                                    |  |                                                                                                                 | 20 | 
|                          
|                          
|                          
|                          
|Item 3.                    |  | Defaults Upon Subordinated Notes                                                     |  |                                                                                                                 | 20 | 
|                          
|                          
|                          
|                          
|Item 4.                    |  | Submission of Matters to a Vote of Security Holders                                  |  |                                                                                                                 | 21 | 
|                          
|                          
|                          
|                          
|Item 6.                    |  | Exhibits and Reports on Form 8-K                                                     |  |                                                                                                                 | 21 | 

2



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##### Table of Contents












PART I    FINANCIAL INFORMATION

ITEM 1. Financial Statements

EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)

|                                                                                       |                                                                                                                                        |                                                                                                   |        |              |        |               |       |          |         |  
|-------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------- | ------ | ------------ | ------ | ------------- | ----- | -------- | ------- | -
|                                                                                       |                                                                                                                                        |                                                                                                   |        | December 31, |        | September 30,
|                                                                                       |                                                                                                                                        |                                                                                                   |        | 2001         |        | 2002         
|ASSETS                                                                                 |                                                                                                                                        |                                                                                                   |        | (unaudited) 
|                                                                                       |                                                                                                                                        |                                                                                                   |        |             
|Current assets:                                                                        |                                                                                                                                        |                                                                                                   |        |              |        |               |       |         
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                       | Cash and cash equivalents                                                                                                              |                                                                                                   | $      | 7,074        |        |               | $     | 1,595    |        
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                       | Accounts receivable, net of allowance for doubtful accounts                                                                            |                                                                                                   |        | 7,031        |        |               |       | 2,688    |        
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                       | Prepaid expenses and other current assets                                                                                              |                                                                                                   |        | 1,874        |        |               |       | 800      |        
|                                                                                       |                                                                                                                                        |                                                                                                   |        |              |        |               |       |         
|                                                                                       |                                                                                                                                        | Total current assets                                                                              |        |              | 15,979 |               |       |          | 5,083   |  
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|Property and equipment, net                                                            |                                                                                                                                        |                                                                                                   | 6,187  |              |        |               | 2,447 |         
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|Goodwill                                                                               |                                                                                                                                        |                                                                                                   | 20,407 |              |        |               |      |         
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|Other intangible assets                                                                |                                                                                                                                        |                                                                                                   | 375    |              |        |               |      |         
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|Other assets                                                                           |                                                                                                                                        |                                                                                                   | 290    |              |        |               | 143   |         
|                                                                                       |                                                                                                                                        |                                                                                                   |        |              |        |               |       |         
|                                                                                       |                                                                                                                                        | Total assets                                                                                      |        | $            | 43,238 |               |       | $        | 7,673   |  
|                                                                                       |                                                                                                                                        |                                                                                                   |        |              |        |               |       |         
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS EQUITY (DEFICIT) |                                                                                                                                        |                                                                                                   |        |              |        |               |       |         
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|Current liabilities:                                                                   |                                                                                                                                        |                                                                                                   |        |              |        |               |       |         
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                       | Accounts payable                                                                                                                       |                                                                                                   | $      | 3,961        |        |               | $     | 2,216    |        
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                       | Accrued expenses                                                                                                                       |                                                                                                   |        | 6,411        |        |               |       | 5,792    |        
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                       | Accrued restructuring expenses                                                                                                         |                                                                                                   |        | 4,716        |        |               |       | 3,019    |        
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                       | Accrued interest related to convertible debentures                                                                                     |                                                                                                   |        | 2,132        |        |               |       | 5,370    |        
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                       | Accrued acquisition reserves                                                                                                           |                                                                                                   |        | 3,086        |        |               |       | 500      |        
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                       | Note payable to certain former shareholders of Customer Analytics                                                                      |                                                                                                   |        | 2,487        |        |               |       | 2,566    |        
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                       | Line of credit                                                                                                                         |                                                                                                   |        | 4,169        |        |               |       | 5,370    |        
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                       | Current portion of capital lease obligations                                                                                           |                                                                                                   |        | 1,232        |        |               |       | 88       |        
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                       | Deferred revenue                                                                                                                       |                                                                                                   |        | 3,975        |        |               |       | 2,256    |        
|                                                                                       |                                                                                                                                        |                                                                                                   |        |              |        |               |       |         
|                                                                                       |                                                                                                                                        | Total current liabilities                                                                         |        |              | 32,169 |               |       |          | 27,177  |  
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|Long term portion of capital lease obligations                                         |                                                                                                                                        |                                                                                                   | 63     |              |        |               | 13    |         
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|Convertible debentures                                                                 |                                                                                                                                        |                                                                                                   | 3,102  |              |        |               | 9,173 |         
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|Series A redeemable convertible preferred stock                                        |                                                                                                                                        |                                                                                                   | 5,650  |              |        |               | 6,968 |         
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|Stockholders equity (deficit):                                                        |                                                                                                                                        |                                                                                                   |        |              |        |               |       |         
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                       | Preferred
Stock; $.001 par value -
 10,000,000 shares authorized, zero shares outstanding at December 31, 2001 and
September 30, 2002, |                                                                                                   |        |             |        |               |       |         |        
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                       | Common Stock, $.001 par value -                                                                                                        |                                                                                                   |        |              |        |               |       |          |        
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                       |                                                                                                                                        | 50,000,000 shares authorized; 1,152,892 shares issued at December 31, 2001 and
September 30, 2002 |        |              | 1      |               |       |          | 1       |  
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                       | Additional paid-in capital                                                                                                             |                                                                                                   |        | 299,547      |        |               |       | 299,724  |        
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                       | Accumulated deficit                                                                                                                    |                                                                                                   |        | (297,030     | )      |               |       | (335,025 | )      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                       | Other comprehensive income                                                                                                             |                                                                                                   |        | (264         | )      |               |       | (357     | )      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                       | Treasury stock, at cost; 12,219 shares at December 31, 2001 and September 30, 2002                                                     |                                                                                                   |        |             |        |               |       |         |        
|                                                                                       |                                                                                                                                        |                                                                                                   |        |              |        |               |       |         
|                                                                                       |                                                                                                                                        | Total stockholders equity (deficit)                                                              |        |              | 2,254  |               |       |          | (35,657 | )
|                                                                                       |                                                                                                                                        |                                                                                                   |        |              |        |               |       |         
|                                                                                       |                                                                                                                                        | Total liabilities and stockholders equity (deficit)                                              |        | $            | 43,238 |               |       | $        | 7,673   |  
|                                                                                       |                                                                                                                                        |                                                                                                   |        |              |        |               |       |         

The accompanying notes are an integral part of these condensed consolidated financial statements.

3



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##### Table of Contents






EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
(In thousands, except per share and share amounts)

|                                                                                 |                                                 |                                      |           |                    |        |                   |           |        |        |      |           |        |         |   |           |        |        |  
|-------------------------------------------------------------------------------- | ----------------------------------------------- | ------------------------------------ | --------- | ------------------ | ------ | ----------------- | --------- | ------ | ------ | ---- | --------- | ------ | ------- | - | --------- | ------ | ------ | -
|                                                                                 |                                                 |                                      |           | Three Months Ended |        | Nine Months Ended
|                                                                                 |                                                 |                                      |           | September 30       |        | September 30     
|                                                                                 |                                                 |                                      |           |                    |        |                  
|                                                                                 |                                                 |                                      |           | 2001               |        | 2002              |           | 2001   |        | 2002
|                                                                                 |                                                 |                                      |           |                    |        |                   |           |        |        |     
|Revenues:                                                                        |                                                 |                                      |           |                    |        |                   |           |        |        |      |           |        |         |   |           |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Software license fees                           |                                      | $         | 3,623              |        |                   | $         | 1,643  |        |      | $         | 17,296 |         |   | $         | 5,705  |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Services and maintenance                        |                                      |           | 5,485              |        |                   |           | 2,830  |        |      |           | 18,379 |         |   |           | 9,696  |       
|                                                                                 |                                                 |                                      |           |                    |        |                   |           |        |        |      |           |        |         |   |           |       
|                                                                                 |                                                 | Total revenues                       |           |                    | 9,108  |                   |           |        | 4,473  |      |           |        | 35,675  |   |           |        | 15,401 |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Cost of revenues:                                                                |                                                 |                                      |           |                    |        |                   |           |        |        |      |           |        |         |   |           |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Software license fees                           |                                      |           | 47                 |        |                   |           | 61     |        |      |           | 549    |         |   |           | 205    |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Services and maintenance                        |                                      |           | 3,205              |        |                   |           | 1,062  |        |      |           | 12,300 |         |   |           | 3,874  |       
|                                                                                 |                                                 |                                      |           |                    |        |                   |           |        |        |      |           |        |         |   |           |       
|                                                                                 |                                                 | Total cost of revenues               |           |                    | 3,252  |                   |           |        | 1,123  |      |           |        | 12,849  |   |           |        | 4,079  |  
|                                                                                 |                                                 |                                      |           |                    |        |                   |           |        |        |      |           |        |         |   |           |       
|Gross profit                                                                     |                                                 |                                      | 5,856     |                    |        |                   | 3,350     |        |        |      | 22,826    |        |         |   | 11,322    |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Operating expenses:                                                              |                                                 |                                      |           |                    |        |                   |           |        |        |      |           |        |         |   |           |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Sales and marketing                             |                                      |           | 5,301              |        |                   |           | 1,718  |        |      |           | 25,029 |         |   |           | 6,145  |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Research and development                        |                                      |           | 3,262              |        |                   |           | 1,832  |        |      |           | 14,637 |         |   |           | 6,046  |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | General and administrative                      |                                      |           | 4,319              |        |                   |           | 1,492  |        |      |           | 13,978 |         |   |           | 5,790  |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Amortization of goodwill and intangibles        |                                      |           | 3,123              |        |                   |           |       |        |      |           | 13,442 |         |   |           |       |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Amortization of MicroStrategy non-current asset |                                      |           | 4,074              |        |                   |           |       |        |      |           | 13,886 |         |   |           |       |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Impairment of goodwill and intangible
assets    |                                      |           |                   |        |                   |           | 20,782 |        |      |           | 19,349 |         |   |           | 20,782 |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Change in accounting estimates (see note
8)     |                                      |           |                   |        |                   |           | (2,538 | )      |      |           |       |         |   |           | (2,538 | )     
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Restructuring charge                            |                                      |           | 8,404              |        |                   |           | 2,288  |        |      |           | 15,864 |         |   |           | 1,820  |       
|                                                                                 |                                                 |                                      |           |                    |        |                   |           |        |        |      |           |        |         |   |           |       
|                                                                                 |                                                 | Total operating expenses             |           |                    | 28,483 |                   |           |        | 25,574 |      |           |        | 116,185 |   |           |        | 38,045 |  
|                                                                                 |                                                 |                                      |           |                    |        |                   |           |        |        |      |           |        |         |   |           |       
|Loss from operations                                                             |                                                 |                                      | (22,627   | )                  |        |                   | (22,224   | )      |        |      | (93,359   | )      |         |   | (26,722   | )     
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Interest income (expense):                                                       |                                                 |                                      |           |                    |        |                   |           |        |        |      |           |        |         |   |           |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Interest income                                 |                                      |           | 30                 |        |                   |           | 10     |        |      |           | 116    |         |   |           | 35     |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Interest expense                                |                                      |           | (2,553             | )      |                   |           | (3,141 | )      |      |           | (4,851 | )       |   |           | (9,833 | )     
|                                                                                 |                                                 |                                      |           |                    |        |                   |           |        |        |      |           |        |         |   |           |       
|                                                                                 |                                                 | Total interest income (expense), net |           |                    | (2,523 | )                 |           |        | (3,131 | )    |           |        | (4,735  | ) |           |        | (9,798 | )
|                                                                                 |                                                 |                                      |           |                    |        |                   |           |        |        |      |           |        |         |   |           |       
|Loss before provision for income taxes                                           |                                                 |                                      | (25,150   | )                  |        |                   | (25,355   | )      |        |      | (98,094   | )      |         |   | (36,520   | )     
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Provision for income taxes                                                       |                                                 |                                      | 21        |                    |        |                   |          |        |        |      | 33        |        |         |   |          |       
|                                                                                 |                                                 |                                      |           |                    |        |                   |           |        |        |      |           |        |         |   |           |       
|Net loss                                                                         |                                                 | $                                    | (25,171   | )                  |        | $                 | (25,355   | )      |        | $    | (98,127   | )      |         | $ | (36,520   | )     
|                                                                                 |                                                 |                                      |           |                    |        |                   |           |        |        |      |           |        |         |   |           |       
|Accretion to redemption value of Series A redeemable
convertible preferred stock |                                                 |                                      | 485       |                    |        |                   | 510       |        |        |      | 1,377     |        |         |   | 1,494     |       
|                                                                                 |                                                 |                                      |           |                    |        |                   |           |        |        |      |           |        |         |   |           |       
|Net loss available to common stockholders                                        |                                                 | $                                    | (25,656   | )                  |        | $                 | (25,865   | )      |        | $    | (99,504   | )      |         | $ | (38,014   | )     
|                                                                                 |                                                 |                                      |           |                    |        |                   |           |        |        |      |           |        |         |   |           |       
|Net loss per common share:                                                       |                                                 |                                      |           |                    |        |                   |           |        |        |      |           |        |         |   |           |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Basic net loss per share applicable to common stockholders                       |                                                 | $                                    | (22.90    | )                  |        | $                 | (22.43    | )      |        | $    | (89.82    | )      |         | $ | (32.97    | )     
|                                                                                 |                                                 |                                      |           |                    |        |                   |           |        |        |      |           |        |         |   |           |       
|Diluted net loss per share applicable to common stockholders                     |                                                 | $                                    | (22.90    | )                  |        | $                 | (22.43    | )      |        | $    | (89.82    | )      |         | $ | (32.97    | )     
|                                                                                 |                                                 |                                      |           |                    |        |                   |           |        |        |      |           |        |         |   |           |       
|Basic weighted average common shares outstanding                                 |                                                 |                                      | 1,120,123 |                    |        |                   | 1,152,892 |        |        |      | 1,107,786 |        |         |   | 1,152,892 |       
|                                                                                 |                                                 |                                      |           |                    |        |                   |           |        |        |      |           |        |         |   |           |       
|Diluted weighted average common shares outstanding                               |                                                 |                                      | 1,120,123 |                    |        |                   | 1,152,892 |        |        |      | 1,107,786 |        |         |   | 1,152,892 |       
|                                                                                 |                                                 |                                      |           |                    |        |                   |           |        |        |      |           |        |         |   |           |       

The accompanying notes are an integral part of these condensed consolidated financial statements.

4



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##### Table of Contents






EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(In thousands)

|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |         |        |        |        |  
|----------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------- | ----------------------------------------- | ------------------------------------- | ------ | ----------------- | ------- | ------- | ------ | ------ | ------ | -
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        | Nine Months Ended
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        | September 30,    
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                  
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        | 2001              |         | 2002   
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |        
|Cash flows from operating activities:                                                                                               |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |        
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    | Net loss                                                                                             |                                                                                                   | $                                         | (98,127                               | )      |                   | $       | (36,520 | )     
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    | Adjustments to reconcile net loss to net cash used in operating activities:                          |                                                                                                   |                                           |                                       |        |                   |         |         |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    |                                                                                                      | Depreciation and other amortization                                                               |                                           |                                       | 3,733  |                   |         |         | 2,402  |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    |                                                                                                      | Amortization of MicroStrategy asset                                                               |                                           |                                       | 13,886 |                   |         |         |       |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    |                                                                                                      | Compensation expense associated with stock options                                                |                                           |                                       | 75     |                   |         |         |       |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    |                                                                                                      | Non-cash interest related to convertible debentures                                               |                                           |                                       | 1,840  |                   |         |         | 8,388  |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    |                                                                                                      | Non cash interest expense related to MicroStrategy obligation                                     |                                           |                                       | 681    |                   |         |         |       |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    |                                                                                                      | Non-cash interest related to notes payable to former Customers Analytics
shareholders             |                                           |                                       | 81     |                   |         |         | 79     |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    |                                                                                                      | Non-cash interest expense related to bridge notes and warrants issued to
Insight Venture Partners |                                           |                                       | 1,493  |                   |         |         |       |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    |                                                                                                      | Amortization of goodwill and intangibles                                                          |                                           |                                       | 13,442 |                   |         |         |       |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    |                                                                                                      | Impairment of goodwill and other intangibles assets                                               |                                           |                                       | 19,349 |                   |         |         | 20,782 |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    |                                                                                                      | Non-cash change in accounting estimate                                                            |                                           |                                       |       |                   |         |         | (2,538 | )     
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    |                                                                                                      | Non-cash interest expense related to warrants issued to Silicon Valley Bank                       |                                           |                                       | 47     |                   |         |         | 40     |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    |                                                                                                      | Non-cash restructuring charge                                                                     |                                           |                                       | 10,486 |                   |         |         | 1,335  |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    |                                                                                                      | Changes in operating assets and liabilities:                                                      |                                           |                                       |        |                   |         |         |        |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    |                                                                                                      |                                                                                                   | Accounts receivable                       |                                       |        | 10,053            |         |         |        | 4,343  |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    |                                                                                                      |                                                                                                   | Prepaid expenses and other current assets |                                       |        | 1,591             |         |         |        | 1,034  |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    |                                                                                                      |                                                                                                   | Accounts payable                          |                                       |        | (129              | )       |         |        | (1,695 | )     
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    |                                                                                                      |                                                                                                   | Accrued expenses                          |                                       |        | (1,104            | )       |         |        | (1,474 | )     
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    |                                                                                                      |                                                                                                   | Deferred revenue                          |                                       |        | (3,200            | )       |         |        | (1,719 | )     
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |        
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           | Net cash used in operating activities |        |                   | (25,803 | )       |        |        | (5,543 | )
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |        
|Cash flows from investing activities:                                                                                               |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |        
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    | Purchases of property and equipment                                                                  |                                                                                                   |                                           | (2,244                                | )      |                   |         | (38     | )     
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    | Proceeds from the sale of property, equipment, and improvements                                      |                                                                                                   |                                           | 118                                   |        |                   |         | 41      |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    | Decrease in other assets                                                                             |                                                                                                   |                                           | 1,694                                 |        |                   |         | 147     |       
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |        
|                                                                                                                                    |                                                                                                      | Net cash (used in) provided by investing activities                                               |                                           |                                       | (432   | )                 |         |         | 150    |       
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |        
|Cash flows from financing activities:                                                                                               |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |        
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    | Proceeds from the issuance of Series A redeemable convertible preferred
stock, net of issuance costs |                                                                                                   |                                           | 4,587                                 |        |                   |         |        |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    | Proceeds from the issuance of notes payable to Insight VentureCapital Partners                       |                                                                                                   |                                           | 6,867                                 |        |                   |         |        |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    | Issuance of Convertible Debentures                                                                   |                                                                                                   |                                           | 19,943                                |        |                   |         |        |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    | Repayments under capital leases                                                                      |                                                                                                   |                                           | (1,534                                | )      |                   |         | (1,194  | )     
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    | Repayment of notes payable to Customer Analytics shareholders                                        |                                                                                                   |                                           | (2,460                                | )      |                   |         |        |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    | Proceeds from bank line of credit                                                                    |                                                                                                   |                                           | 3,671                                 |        |                   |         | 1,201   |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    | Issuance of common stock under ESPP                                                                  |                                                                                                   |                                           | 230                                   |        |                   |         |        |       
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    | Exercise of common stock options                                                                     |                                                                                                   |                                           | 173                                   |        |                   |         |        |       
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |        
|                                                                                                                                    |                                                                                                      | Net cash provided by financing activities                                                         |                                           |                                       | 31,477 |                   |         |         | 7      |       
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |        
|Effect of exchange rate changes on cash and cash equivalents                                                                        |                                                                                                      |                                                                                                   | (56                                       | )                                     |        |                   | (93     | )      
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |        
|Net increase (decrease) in cash and cash equivalents                                                                                |                                                                                                      |                                                                                                   | 5,186                                     |                                       |        |                   | (5,479  | )      
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |        
|Cash and cash equivalents, beginning of period                                                                                      |                                                                                                      |                                                                                                   | 8,617                                     |                                       |        |                   | 7,074   |        
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |        
|Cash and cash equivalents, end of period                                                                                            |                                                                                                      | $                                                                                                 | 13,803                                    |                                       |        | $                 | 1,595   |        
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |         |       
|Supplemental disclosure of cash flow information                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |        
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                    | Cash paid for interest                                                                               |                                                                                                   | $                                         | 356                                   |        |                   | $       | 273     |       
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |         |       
|                                                                                                                                    | Cash paid for income taxes                                                                           |                                                                                                   | $                                         | 12                                    |        |                   |         |        |       
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |         |       
|Effect of beneficial conversion feature on Series A redeemable convertible
preferred stock                                          |                                                                                                      | $                                                                                                 | 2,094                                     |                                       |        |                   |        |        
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |         |       
|Issuance of warrants to Insight Venture Partners                                                                                    |                                                                                                      | $                                                                                                 | 16,389                                    |                                       |        |                   |        |        
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |         |       
|Effect of Beneficial conversion feature on Convertible Debentures to Insight
Capital Partners                                       |                                                                                                      | $                                                                                                 | 11,913                                    |                                       |        |                   |        |        
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |         |       
|Issuance of warrants to Silicon Valley Bank                                                                                         |                                                                                                      | $                                                                                                 | 153                                       |                                       |        |                   |        |        
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |         |       
|Accretion of dividends and discount on Series A redeemable convertible
preferred stock                                              |                                                                                                      | $                                                                                                 | 667                                       |                                       |        | $                 | 763     |        
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |         |       
|Accretion of discount, offering costs, and beneficial conversion feature on
issuance of Series A redeemable preferred stock         |                                                                                                      | $                                                                                                 | 710                                       |                                       |        | $                 | 731     |        
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |         |       
|Conversion of notes payable to Insight Venture Partners into Series A
redeemable convertible preferred stock                        |                                                                                                      | $                                                                                                 | 1,500                                     |                                       |        |                   |        |        
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |         |       
|Issuance of common stock related to stock subscription and to settle
obligation to Microstrategy, Incorporated and related interest |                                                                                                      | $                                                                                                 | 17,514                                    |                                       |        |                   |        |        
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |         |       
|Equipment acquired under capital
lease                                                                                              |                                                                                                      | $                                                                                                 | 322                                       |                                       |        |                   |        |        
|                                                                                                                                    |                                                                                                      |                                                                                                   |                                           |                                       |        |                   |         |         |       

The accompanying notes are an integral part of these condensed consolidated financial statements.

5



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##### Table of Contents






EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(1) Background and Basis of Presentation

Exchange Applications, Inc. and its subsidiaries, doing business as
Xchange, Inc., provides Customer Relationship Management (CRM) solutions that
help companies earn a greater share of their customers business through
relevant, personalized customer communications. Xchange provides an
open-platform CRM software and services solution that enables clients to
customize offers based on profile information, synchronize offers across all
customer channels in real-time and track the responses. This solution provides
companies with the opportunity to improve their acquisition and retention of
customers and increase customer relationship profitability.

Xchange is subject to a number of risks common to rapidly growing
technology-based companies, including limited operating history, dependence on
key individuals, rapid technological changes, competition from substitute
products and larger companies, high customer concentration, and the need for
successful development and marketing of its commercial products and services.

Xchange has sustained net losses and negative cash flows from operations
in 2000, 2001 and the nine months ended September 30, 2002. In addition, at
September 30, 2002, Xchange had a significant working capital deficit and
certain notes payable that matured in June 2002 have been left unpaid.
Xchanges ability to meet its obligations in the ordinary course of the
business and to continue as a going concern is dependent on its ability to
reduce net operating expenses and refinance its existing obligations, or raise
additional financing through public and private equity financing or other
sources of financing. There is no assurance that Xchange will be successful in
its efforts to raise additional capital, renegotiate its existing obligations
or to sufficiently reduce its operating expenses, all of which may have a
material adverse impact on Xchanges solvency.

(2) Summary of Significant Accounting Policies

(a) Principles of Consolidation

The accompanying consolidated financial statements are unaudited and have
been prepared in accordance with generally accepted accounting principles.
These statements include the accounts of Exchange Applications, Inc. and its
wholly owned subsidiaries.

(b) Interim Financial Reporting

Certain information and footnote disclosures normally included in
Xchanges annual consolidated financial statements have been condensed or
omitted. The interim condensed consolidated financial statements, in the
opinion of management, reflect all adjustments (consisting only of normal
recurring accruals) necessary for a fair presentation of the operating results
for the interim periods ended September 30, 2001 and 2002, respectively. The
results of operations for the interim periods are not necessarily indicative of
the results of operations to be expected for the entire year. It is suggested
that these interim consolidated financial statements be read in conjunction
with the audited consolidated financial statements for the year ended December
31, 2001, which are contained in Xchanges Annual Report on Form 10-K filed
with the Securities and Exchange Commission on May 14, 2002.

(c) Net Loss Per Share

In accordance with Statement of Financial Accounting Standards (SFAS)
No. 128, Earnings per Share, basic and diluted net loss per common share for
the three and nine months ended September 30, 2001 and 2002 is calculated by
dividing the net loss applicable to common stockholders by the weighted average
number of common shares outstanding.

6



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##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Diluted
weighted average shares outstanding for the three and nine months
ended September 30, 2001 and 2002 exclude the potential common shares from stock
options, warrants and Series A redeemable convertible preferred stock because
to include such shares would have been antidilutive. As of September 30, 2001
and 2002, 5,562,985 and 7,540,964 potential common shares were outstanding,
respectively.

(d)  Comprehensive Income (Loss)

Xchange has adopted SFAS No. 130, Reporting Comprehensive Income. SFAS
No. 130 requires that items defined as other comprehensive income (loss), such
as foreign currency translation adjustments, be separately classified in the
financial statements and that the accumulated balance of other comprehensive
income (loss) be reported separately from retained earnings and additional
paid-in capital in the equity section of the balance sheet. The components of
comprehensive income (loss) for the three and nine months ended September 30,
2001 and 2002 are as follows:

|                             |                                    |                             |   |                    |      |                   |   |         |     |      |   |         |     |   |   |         |     |  
|---------------------------- | ---------------------------------- | --------------------------- | - | ------------------ | ---- | ----------------- | - | ------- | --- | ---- | - | ------- | --- | - | - | ------- | --- | -
|                             |                                    |                             |   | Three months ended |      | Nine months ended
|                             |                                    |                             |   | September 30,      |      | September 30,    
|                             |                                    |                             |   |                    |      |                  
|                             |                                    |                             |   | 2001               |      | 2002              |   | 2001    |     | 2002
|                             |                                    |                             |   |                    |      |                   |   |         |     |     
|                             |                                    |                             |   | (in thousands)     |      | (in thousands)   
|Comprehensive income (loss): |                                    |                             |   |                    |      |                   |   |         |     |      |   |         |     |   |   |        
|                            
|                            
|                            
|                            
|                             | Net income (loss)                  |                             | $ | (25,171            | )    |                   | $ | (25,355 | )   |      | $ | (98,127 | )   |   | $ | (36,520 | )  
|                            
|                            
|                            
|                            
|                             | Other comprehensive income (loss): |                             |   |                    |      |                   |   |         |     |      |   |         |     |   |   |         |    
|                            
|                            
|                            
|                            
|                             |                                    | Foreign currency adjustment |   |                    | (122 | )                 |   |         | (15 | )    |   |         | (56 | ) |   |         | (93 | )
|                             |                                    |                             |   |                    |      |                   |   |         |     |      |   |         |     |   |   |         |    
|                             | Comprehensive income (loss)        |                             | $ | (25,293            | )    |                   | $ | (25,370 | )   |      | $ | (98,183 | )   |   | $ | (36,613 | )  
|                             |                                    |                             |   |                    |      |                   |   |         |     |      |   |         |     |   |   |         |    

(e) Change in Accounting Estimate Related to Accrued Acquisition Costs

Xchange had
accrued acquisition reserves from the acquisitions of Knowledge
Stream Parters and Customer Analytics which were based on estimated costs in
the year 2000. Based on revised estimates, Xchange has determined the
majority of the accruals are no longer needed and have accordingly reduced them
in September 2002.

(3) Restructuring Charges

During the third quarter of 2002, Xchange continued to undertake certain
restructuring actions to better align its cost structure with its outlook on
near-term revenues and to conserve cash. The components of the restructuring
charges resulting from these actions are as follows (in thousands):

|                       |  |   |       | 
|---------------------- |  | - | ----- | 
|Severance              |  | $ | 253   | 
|                      
|                      
|                      
|                      
|Facilities and related |  |   | 1,254 | 
|                      
|                      
|                      
|                      
|Property and equipment |  |   | 781   | 
|                       |  |   |       | 
|                       |  | $ | 2,288 | 
|                       |  |   |       | 

Severance costs relate to the elimination of 14 managerial and staff
positions worldwide, comprising approximately 9% of the beginning of the year
workforce in the following areas: two in sales and marketing, and twelve in
professional services. Property and equipment relate to non-cash write-offs of
excess office furniture and computer equipment that has been removed from
operations as a result of employee reductions. Facility related costs relate
to the abandonment of excess facilities.

7



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##### Table of Contents



The following summarizes the activity in Xchanges restructuring accruals
through September 30, 2002:

|                   |  |                       |       |              |  |               |     |      |  |                  |       |  |  |                       |       | 
|------------------ |  | --------------------- | ----- | ------------ |  | ------------- | --- | ---- |  | ---------------- | ----- |  |  | --------------------- | ----- | 
|                   |  |                       |       |              |  |               |     |      |  |                  |       |  |  | Restructuring accrual
|                   |  | Restructuring accrual |       | Additions    |  |               |     |      |  | at September 30,
|                   |  | at December 31, 2001  |       | (Reductions) |  | Cash payments |     | 2002
|                   |  |                       |       |              |  |               |     |     
|                   |  | (in thousands)       
|Severance          |  | $                     | 245   |              |  | $             | 560 |      |  | $                | 655   |  |  | $                     | 150   | 
|                  
|                  
|                  
|                  
|Facilities related |  |                       | 3,992 |              |  |               | (74 | )    |  |                  | 1,317 |  |  |                       | 2,601 | 
|                  
|                  
|                  
|                  
|Others             |  |                       | 479   |              |  |               |    |      |  |                  | 211   |  |  |                       | 268   | 
|                   |  |                       |       |              |  |               |     |      |  |                  |       |  |  |                       |       | 
|Total              |  | $                     | 4,716 |              |  | $             | 486 |      |  | $                | 2,183 |  |  | $                     | 3,019 | 
|                   |  |                       |       |              |  |               |     |      |  |                  |       |  |  |                       |       | 

The severance accrued at September 30, 2002 relates primarily to 14
employees who positions were eliminated in September 2002. The severance
accrual will be paid out in installments through January 8, 2003. Facility
costs will be paid out through 2005 based on the remaining lease terms of the
abandoned facilities. Other accruals relate to non-cancelable payments due for
marketing events which have been canceled as a result of Xchanges cost
containment initiatives.

(5) Bank Line of Credit

On May 3, 2002, Xchange restructured its credit facilities with Silicon
Valley Bank (SVB).

Xchanges existing credit facility was modified to provide for advances of
up to $4.0 million on a revolving basis (the Guarantied Line). Xchanges
ability to obtain advances is conditioned upon the absence of any Defaults
or Events of Default (as defined in the loan documentation). The Guarantied
Line is secured by a lien on all of Xchanges assets and is guaranteed (the
Insight Guaranty) by Insight Venture Partners (Insight). SVB required the
Insight Guaranty in order to provide the Guarantied Line. Advances under the
Guarantied Line bear interest at SVBs prime rate plus 0.50% per annum and
mature on May 3, 2003. In consideration for Insight agreeing to provide the
Insight Guaranty, Xchange entered into a Securities Purchase Agreement, dated
as of May 3, 2002, with Insight, pursuant to which Xchange has issued to Insight promissory
notes (collectively, the Insight Note) that will evidence the obligations of
Xchange to reimburse Insight in the event that Insight is
required to make any payments to SVB under the Insight Guaranty. The Insight
Note bears interest on the unpaid amount thereof at a rate of 2% per month (3%
per month after default) and is payable within 30 days after any
payment is made by Insight under the Insight Guaranty. In addition, in
consideration for Insight agreeing to provide the Insight Guaranty, Xchange
issued to Insight a Contingent Value Right (the CVR). Under the terms of the
CVR, Insight may request that Xchange redeem the CVR for a cash payment equal
to the CVR Value based on the occurrence of a Trigger Event. Trigger
Events include: (a) a sale of Xchange (as defined therein); (b) Xchange
achieving trailing 12 month consolidated revenues in excess of $50 million (the
Revenue Target), or (c) Xchange achieving trailing 12 month consolidated
earnings before interest, taxes, depreciation and amortization expense in
excess of $10.0 million. The CVR Value upon the occurrence of a Trigger Event
will be $3.0 million, except that if the event giving rise to the Trigger Event
is the achievement of the Revenue Target, the CVR Value will be the greater of
$3.0 million and 7% of Xchanges consolidated revenues (not to exceed $10.0
million).

On September 16, 2002, the terms of the Guarantied Line were modified to
allow for advances of up to $5.5 million in the aggregate at any time
outstanding. As a condition to the increase in the Guaranteed Line, the
Insight Guaranty was amended and restated to increase the maximum amount
guaranteed thereunder to $5.5 million.

An additional accounts receivables financing facility was also established
on May 3, 2002 (the Receivables Line). The Receivables Line provided for
advances of up to $4.0 million and matures on May 3, 2003. Under the

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terms of the Receivables Line, SVB may, in its sole discretion, make
advances to Xchange based upon a percentage, determined by SVB, of the face
amount of Xchanges accounts receivables that satisfy certain criteria,
provided that no Events of Default (as in the loan documentation) exist. The Receivables
Line is secured by a lien on all of Xchanges assets, but is not guaranteed by
Insight. Advances under the Receivables Line bear interest at
SVBs prime rate plus 2.50% per annum.

On August 15, 2002, the terms of the Receivables Line were amended to
reduce the maximum amount available thereunder from $4.0 million to $1.5
million.

(6) Offer from Investor Group

On May 3, 2002, Xchange announced it had received a preliminary offer from
a group led by Insight to acquire Xchange. The offer is non-binding and subject
to customary conditions, including the execution of definitive agreements.
Xchanges Board of Directors has formed a Special Independent Committee to
evaluate the offer.

(7) Asset Impairment Writeoffs

In accordance
with SFAS No. 142, Goodwill and Other Intangible Assets,
goodwill and intangible assets deemed to have indefinite lives will no longer
be amortized, but instead will be subject to periodic impairment testing under
a fair value approach. Xchange applied these new rules beginning January 1,
2002 and ceased amortizing goodwill. Goodwill, net of accumulated amortization,
as of December 31, 2001 was $20,782. This goodwill balance was created as a
result of Xchanges March 2000 acquisition of Knowledge Stream Partners. In
September 2002, Xchange determined that the remaining goodwill balance was
impaired based on the number of employees left from the acquired entity, the
lack of customers and revenue the intangible asset had created, and the current
valuation of Xchange. Based on Xchanges assessment of the value of the
goodwill, management wrote off the remaining goodwill as an impaired asset. As
a result of testing goodwill for impairment in accordance with SFAS No. 142 as
of September 30, 2002, Xchange recorded a non-cash impairment charge of
$20,782, or $18.03 loss per share.

(8) Change in Accounting Estimates

Xchange
had previously accrued for costs associated with the acquisitions
of Knowledge Stream Partners and Customer Analytics. Based on new estimates by
management, Xchange reversed accruals of approximately $2.5 million during the
three month period ended September 30, 2002. This was accounted for as a
change in accounting estimate and is included in the condensed consolidated
statement of operations.

(9) Recent Accounting Pronouncemnts

On January 1, 2002, Xchange adopted SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, which addresses financial
reporting for the impairment or disposal of long-lived assets. SFAS No. 144
supersedes SFAS No. 121 and the accounting and reporting provisions of APB 30
related to the disposal of a segment of a business. The adoption of this
statement did not have a significant effect on Xchanges financial position or
results of operations.

The Financial Accounting Standards Board (FASB) issued SFAS No. 145,
Rescission of FASB Statements No. 4, 44, and 64, Amendments No. 13, and
Technical Corrections, effective for fiscal years beginning May 15, 2002 or
later that rescinds FASB Statement No. 4, Reporting Gains and Losses from
Extinguishment of Debt, FASB Statement No. 64, Extinguishment of Debt Made to
Satisfy Sinking-Fund Requirements,and FASB Statement No. 44, Accounting for
Intangible Assets of Motor Carriers. This Statement amends SFAS No. 4 and SFAS
No. 13, Accounting for Leases, to eliminate an inconsistency between the
required accounting for sale-leaseback transactions. This Statement also amends
other existing authoritative pronouncements to make various technical
corrections, clarify meanings, or describe their applicability under changed
conditions. The provisions of this Statement related to SFAS No. 13 shall be
effective for transactions occurring after May 15, 2002, with early application
encouraged. All other provisions of this Statement shall be effective for
financial statements issued on or

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after May 15, 2002, with early application encouraged. Xchange plans to adopt
SFAS No. 145 on January 1, 2003 and does not believe adopting SFAS No. 145 will
have a material impact on its consolidated financial statements.

In July 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. SFAS No. 146 is based on the
fundamental principle that a liability for a cost associated with an exit or
disposal activity should be recorded when it (1) is incurred, that is, when it
meets the definition of a liability in FASB Concepts Statement No. 6, Elements
of Financial Statements, and (2) can be measured at fair value. The principal
reason for issuing SFAS No. 146 is the Boards belief that some liabilities for
costs associated with exit or disposal activities that entities record under
current accounting pronouncements, in particular EITF Issue 94-3, do not meet
the definition of a liability. SFAS No. 146 nullifies EITF Issue 94-3; thus, it
will have a significant effect on practice because commitment to an exit or
disposal plan no longer will be a sufficient basis for recording a liability
for costs related to those activities. SFAS No. 146 is effective for exit and
disposal activities initiated after December 31, 2002. Early application is
encouraged; however, previously issued financial statements may not be
restated. An entity would continue to apply the provisions of EITF Issue 94-3
to an exit activity that is initiated under an exit plan that met the criteria
of EITF Issue 94-3 before the entity initially applied SFAS No. 146.




Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.

This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. These statements include, but are not
limited to, statements regarding contingencies, future prospects, liquidity and
capital expenditures herein under Part I Financial Information-Item 2
Managements Discussion and Analysis of Financial Condition and Results of
Operations. Actual results could differ materially from those projected in
the forward-looking statements as a result of the risk factors set forth below
and detailed in our other filings with the Commission during the past 12
months.

Overview

Xchange provides CRM solutions that help companies earn a greater share of
their customers business through relevant, personalized customer
communications. Xchange provides an open-platform CRM software and services
solution that is designed to help clients customize offers based on profile
information, synchronize offers across multiple customer channels in real-time
and track the responses. This solution is designed to provide companies with
opportunities to improve their acquisition and retention of customers and to
increase customer relationship profitability. Xchanges CRM solutions are
licensed for use at approximately 300 client sites in 33 countries, as well as
the six leading U.S. marketing service bureaus.

Corporate Overview

Xchange was incorporated in November 1996. Prior to incorporation,
Xchange operated as a separate division of two entities, Grant & Partners, Inc.
and Grant & Partners Limited Partnership. Xchanges activities during its early
stages of operation focused on the development of software solutions to provide
customer communications support to businesses. In 1995, Xchange began
providing professional services in the areas of marketing program design and
execution and data warehousing. In March 1997, Xchange ceased providing
marketing program design services. Xchanges development efforts culminated in
the introduction to market in July 1996 of Xchange Campaign. Since this
initial introduction of Xchange Campaign, Xchange has continued to focus
significant resources on the development of additional functionality and
features of its original products as well as the development and acquisition
of additional solutions within Xchanges CRM solution set including Xchange
Real Time, Xchange eMessaging and Xchange Analytics. In October 2001 Xchange
announced Xchange 8, which is a bundling of Xchanges existing products, as
part of a strategy to move away from selling individual software components to
selling an integrated set of software solutions

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Xchange also has continued to expand its marketing activities, build its
identity, develop the competencies of the professional services group,
establish international sales and distribution channels and develop its general
and administrative infrastructure.

In August 1999, Xchange acquired eXstatic Software, Inc. (formerly known
as Gino Borland, Inc.) (eXstatic) in a transaction accounted for as a pooling
of interest. eXstatic develops and markets software products that enable
businesses to plan, create and execute highly personalized, permission-based
email communications based on customer profiles. In accordance with pooling of
interests accounting, the results of operations have been restated to reflect
the historical results of eXstatic on an as combined basis. In September 2002,
Xchange ceased providing permission-based email communications. On March 31,
2000, Xchange acquired KSP in a transaction accounted for under the purchase
method. KSP specializes in consulting and software development for advanced
data mining and online/offline analytics. In June 2000, Xchange acquired
Customer Analytics, Inc. (CA) in a transaction accounted for under the
purchase method. CA develops and markets campaign management solutions focused
on creating, executing, analyzing and measuring customer communications at the
local or branch level.

Critical Accounting Policies and Significant Judgements and Estimates

Xchanges discussion and analysis of its financial condition and results
of operations are based on Xchanges consolidated financial statements which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of these financial statements
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements and the reported revenues
and expenses during the reporting periods. Management bases its estimates on
historical experience and on various other factors that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgements about the timing and amounts of certain transactions and
carrying value of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.

The significant accounting policies that management believes are most
critical to aid in fully understanding and evaluating our reported financial
results include the following:

Revenue Recognition

Xchanges revenues are primarily generated from the sale of perpetual
licenses to its proprietary Xchange 8 products and services. Xchange generates
its services revenue from consulting and training services performed for
customers and from maintenance and support. As described below, significant
management judgements and estimates must be made and used in connection with
the revenue recognized in any accounting period. Material differences may
result in the amount and timing of our revenue for any period if management
made different judgements or utilized different estimates.

Xchange recognizes revenue based on the provisions of Staff Accounting
Bulletin 101, Revenue Recognition in Financial Statements, Statement of
Position, (SOP), No. 97-2, Software Revenue Recognition, as amended by SOP
No. 98-4 and SOP No. 98-9, and the provisions of SOP No. 81-1, Accounting for
Performance of Construction-Type and Certain Production-Type Contracts.Xchange
recognizes revenue from the sale of software licenses when persuasive evidence
of an arrangement exists, the product has been delivered, the fees are fixed or
determinable and collection of the resulting receivable is reasonably assured.
Xchange does not offer a right of return on its products.

For all sales, Xchange uses either a binding purchase order or signed
license agreement as evidence of an arrangement. At the time of the
transaction, Xchange assesses whether the fee associated with the transaction
is fixed or determinable based on the payment terms associated with the
transaction. If a significant portion of the fee is due after our normal
payment terms Xchange accounts for the fee as not being fixed or determinable.
In these cases, Xchange recognizes revenue as the fees become due. Credit
worthiness for follow-on transactions is assessed through a review of the
transaction history with the customer. Xchange does not request collateral
from its

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customers. If collection of a fee is not reasonably assured, Xchange
defers the fee and recognizes revenue at the time collection becomes reasonably
assured, which is generally upon receipt of cash.

Software license fee revenues are generated from licensing the rights to
the use of Xchanges packaged software products. Services and maintenance
revenues are generated from sales of maintenance, consulting, training and
hosting services performed for customers that license Xchanges products.
Xchange has concluded that effective with the new generation of Xchange
Analytics and Xchange Real Time, certain of the implementation services related
to these products are essential to the customers use of the packaged software
products. Similarly, the implementation services for the Xchange EnAct product
is essential to the customers use of those packaged software products. For
sales of these products where Xchange is responsible for implementation,
Xchange recognizes revenue for these arrangements following the
percentage-of-completion method over the implementation period. Percentage of
completion is measured by the percentage of implementation hours incurred to
date compared to estimated total implementation hours. This method is used
because management has determined that expended hours to be the best measure of
progress on these engagements. In situations where Xchange is not responsible
for implementation services, or where the product configuration being delivered
does not require the implementation services deemed to be essential to the
customers use of the software, Xchange recognizes revenue on delivery of the
packaged software if there is persuasive evidence of an arrangement, collection
is probable, the fee is fixed or determinable and vendor-specific objective
evidence exists to allocate the total fees to all undelivered elements of the
arrangement.

Vendor-specific objective evidence is based on the price charged when an
element is sold separately or, in the case of an element not yet sold
separately, the price established by authorized management, if it is probable
that the price, once established, will not change before market introduction.
Elements included in multiple-element arrangements could consist of software
products, maintenance, consulting and training services.

Revenue from maintenance services is recognized ratably over the term of
the contract, typically one year. Professional services revenue is primarily
related to implementation and consulting services performed on a
time-and-materials basis under separate service arrangements. Revenues from
professional service arrangements are recognized on either a time and materials
or percentage-of-completion basis as the services are performed, provided that
amounts due from customers are fixed or determinable and deemed collectible by
management. In addition, Xchange recognizes consulting revenue for its
application hosting service. The revenue is recognized over the service
delivery period based on either a pre-determined monthly service fee or a usage
based pricing model.

In certain situations, Xchange has entered into transactions with third
parties to acquire technology from those entities at the same time that Xchange
sells its technology to those same third parties. In those instances, Xchange
applies Accounting Principles Board Opinion No. 29, Accounting for Nonmonetary
Transactions, and Emerging Issues Task Force Issue No. 86-29, Nonmonetary
Transactions: Magnitude of the Boot and the Exceptions to the Use of Fair
Value,to such transactions.

Revenues for maintenance and support are recognized ratably over the term
of the support period. Revenues from consulting and training services are
recognized as the services are performed.

Goodwill and Intangibles

Purchase accounting requires extensive use of accounting estimates and
judgements to allocate the purchase price to the fair market value of the
assets purchased and liabilities assumed. In recording the acquisition of KSP
in March 2000, and CA in June 2000, values were assigned to intangible assets
for assembled workforces, acquired technology and existing customer bases. The
value assigned to these assets were based on independent third-party
appraisals. The excess of the purchase price over the fair value of assets
acquired was recorded as goodwill.

Intangible assets are tested for impairment whenever events or changes in
circumstances indicate that the carrying value for the asset may not be
recoverable. In 2001, Xchange recorded impairment charges relative to its
investment in the technology of MicroStrategy, Inc. (MicroStrategy) and
acquisition of CA. In both instances Xchange made

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the strategic decision to no longer sell or support the products or assets
underlying the original acquisitions. During the fourth quarter of 2001, in
response to continuing negative operating trends, Xchange determined that the
remaining goodwill balance was impaired based upon a third-party indication of
value of Xchange as a whole. Xchange recorded an additional impairment charge
of the carrying value of such goodwill in the amount of $3.8 million. In
September 2002, Xchange determined that the remaining goodwill balance of $20.8
million was impaired based on the number of employees left from the original
entity, the lack of customers the intangible asset has created, and the current
valuation of Xchange. Based on managements assessment of the valuation of
goodwill, Xchange wrote off the remaining goodwill of $20.8 million as an
impaired asset.

(4) Restructuring Charges

During the third quarter of 2002, Xchange continued to undertake certain
restructuring actions to better align its cost structure with its outlook on
near term revenues and to conserve cash. The components of the restructuring
charges resulting from these actions are as follows (in thousands):

|                       |  |   |       | 
|---------------------- |  | - | ----- | 
|Severance              |  | $ | 253   | 
|                      
|                      
|                      
|                      
|Facilities and related |  |   | 1,254 | 
|                      
|                      
|                      
|                      
|Property and equipment |  |   | 781   | 
|                       |  |   |       | 
|                       |  | $ | 2,288 | 

Severance costs relate to the elimination of 14 managerial and staff
positions worldwide, comprising approximately 9% of the beginning of the year
workforce in the following areas: two in sales and marketing, and fourteen in
professional services. Property and equipment relate to non-cash write-offs of
excess office furniture and computer equipment that has been removed from
operations as a result of employee reductions. Facility related costs relate
to the abandonment of excess facilities.

The following summarizes the activity in Xchanges restructuring accruals
through September 30, 2002:

|                   |  |                       |       |              |  |                |     |                       |  |                       |       |  |  |   |       | 
|------------------ |  | --------------------- | ----- | ------------ |  | -------------- | --- | --------------------- |  | --------------------- | ----- |  |  | - | ----- | 
|                   |  | Restructuring accrual |       | Additions    |  |                |     |                       |  | Restructuring accrual
|                   |  | at December 31, 2001  |       | (Reductions) |  | Cash payments  |     | at September 30, 2002
|                   |  |                       |       |              |  |                |     |                      
|                   |  |                       |       |              |  | (in thousands) |     |                       |  |                       |       |  |  |  
|Severance          |  | $                     | 245   |              |  | $              | 560 |                       |  | $                     | 655   |  |  | $ | 150   | 
|                  
|                  
|                  
|                  
|Facilities related |  |                       | 3,992 |              |  |                | (74 | )                     |  |                       | 1,317 |  |  |   | 2,601 | 
|                  
|                  
|                  
|                  
|Others             |  |                       | 479   |              |  |                |    |                       |  |                       | 211   |  |  |   | 268   | 
|                   |  |                       |       |              |  |                |     |                       |  |                       |       |  |  |   |       | 
|Total              |  | $                     | 4,716 |              |  | $              | 486 |                       |  | $                     | 2,183 |  |  | $ | 3,019 | 
|                   |  |                       |       |              |  |                |     |                       |  |                       |       |  |  |   |       | 

The severance accrued at September 30, 2002 relates primarily to 14
employees who positions were eliminated in September 2002. The severance
accrual will be paid out in installments through January 8, 2003. Facility
costs will be paid out through 2005 based on the remaining lease terms of the
abandoned facilities. Other accruals relate to non-cancelable payments due for
marketing events which have been canceled as a result of the Companys cost
containment initiatives.

Three Months Ended September 30, 2001 and 2002

Revenues

Xchanges total revenues decreased by $4.6 million, or 50.9%, from $9.1
million in Q3 2001 to $4.5 million in Q3 2002. Software license fees decreased
by $2.0 million, or 54.7%, from $3.6 million in Q3 2001 to $1.6 million in Q3
2002. Included in software license fee revenue in Q3 2001 was $1.1 million
from Carreker Corporation (Carreker) related to guaranteed royalties on sales
of the EnAct product. In Q4 2001, Xchange decided to discontinue the sales and
support of the EnAct product and sold the EnAct technology to Carreker,
therefore there

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was no comparable EnAct royalty revenue in Q3 2002. The remaining
decrease is attributed primarily to fewer sales resulting from a general market
slowdown in information technology spending.

Services and maintenance revenues decreased by $2.6 million, or 48.4%,
from $5.5 million in Q3 2001 to $2.8 million at Q3 2002. The decrease is
attributed to decreases in services engagement revenue of $1.0 million,
eMessaging ASP revenue of $.6 million and maintenance revenue of $1.0 million.
The decrease in services engagement revenue is due partially to the reduction
in software license fees revenue, resulting in reduced software implementation
and integration services. The decrease in eMessaging ASP revenue reflects the
growing competition for these services due to excess eMessaging capacity in the
marketplace. The decrease in maintenance reflects the decrease in Xchanges
base of customers due to customers electing to not renew annual maintenance.

Cost of Revenues

Cost of software license fees consists primarily of royalty payments made
to third-parties for licensed intellectual property included in Xchange
software products, and cost associated with software packaging and
distribution. The cost of software license fees increased in absolute dollars
from $47,000 in Q3 2001 to $61,000 in Q3 2002. It increased as a percentage of
software license fee revenue from 1.3% to 3.7%. The slight increase as a
percentage of software license fee revenue is due to a decrease in license
revenue.

Cost of services and maintenance consists primarily of personnel,
facilities and system costs incurred in providing professional consulting
services, training, hosting software services for the Xchange eMessaging
software product, and customer support services. Cost of services and
maintenance as a percentage of services and maintenance revenue was 58.4% in Q3
2001 and 37.5% in Q3 2002. The decrease in cost of services and maintenance in
both absolute dollars and a percentage of services and maintenance revenues is
due primarily to corrective actions Xchange took throughout the later half of
2001 and into Q3 of 2002 designed to adjust its infrastructure costs downward
to better match the lower anticipated level of revenues.

Overall gross profit percentage improved from 64.3% in Q3 2001 to 74.9% in
Q3 2002, as a result of Xchanges costs containment restructuring efforts.

Operating Expenses

Sales and marketing expense consists primarily of employee salaries and
benefits for sales and marketing personnel, commissions and promotional
expenses. Sales and marketing expense decreased by $3.6 million, or 67.6%, from
$5.3 million in Q3 2001 to $1.7 million in Q3 2002. Sales and marketing
expenses decreased as a percentage of revenue from 58.2% in Q3 2001 to 38.4% in
Q3 2002. The decrease is due to Xchanges corrective actions in the later half
of 2001 and into Q3 of 2002 designed to adjust its infrastructure costs
downward to better match the lower anticipated revenues.

Research and development expense consists primarily of employee salary and
benefits, consultant costs and equipment and software maintenance costs
associated with new product development, enhancement of existing products and
quality assurance activities. Research and development costs decreased by $1.4
million, or 43.8% from $3.3 million in Q3 2001 to $1.9 million in Q3 2002.
Research and development costs as a percentage of revenue increased from 35.8%
in Q3 2001 to 41.0% in Q3 2002. The decrease in absolute dollars is due
primarily to corrective actions Xchange took beginning in the latter part of
2001 and continuing into Q3 2002 to reprioritize its investments and commitment
to existing and new product offerings and features given its reduced revenue
base and need to conserve cash.

General and administrative expense consists primarily of employee salaries
and related costs, outside professional fees, provision for uncollectible
accounts receivable and equipment and software depreciation cost associated
with the finance, legal, human resources, information systems and executive
functions of Xchange. General and administrative expenses decreased $2.8
million, or 65.5%, from $4.3 million in Q3 2001 to $1.5 million in Q3 2002. The
decrease is the result of corrective actions Xchange took in the later part of
2001 and into Q3 of 2002 designed

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to reduce general and administrative expenses in line with the overall
reduced infrastructure needs of Xchange and the need to conserve cash.

Goodwill and intangibles

In 2001, the Company amortized its purchased intangibles and its
investment in MicroStrategy assets over these assets estimated useful lifes in
accordance with then generally accepted accounting principals. In Q4 2001, the
Company recorded impaired charges to fully write-off its investments in
MicroStrategy assets and intangible assets related to the acquisition of CA,
and to partially write-off its intangible assets associated with the KSP
acquisition. Effective January 1, 2002, the Company adopted SFAS No. 142,
Goodwill and Other Intangibles(SFAS 142), and accordingly will no longer
amortize purchased intangibles over their estimated useful life. Rather,
intangible assets will be subject to annual assessments of impairment. In
September 2002, the Company determined that the remaining goodwill balance of
$20.8 million was impaired based on the number of employees left from the
original entity, the lack of customers the intangible asset has created, and
the current valuation of the company. Based on discounted net cash flows
management wrote off the remaining goodwill of $20.8 million as an impaired
asset.

Interest income (expense), net

Interest expense, net in Q3 2001 was comprised of $115,000 of non-cash
interest expense associated with the MicroStrategy obligation, $594,000 of
non-cash interest associated with the amortization of discounts of the issuance
of $4.5 million of convertible notes and warrants to Insight, $64,000 in
interest payable on convertible notes payable to certain former shareholders of
CA, $83,000 in interest on capital leases and other lease obligations, $25,000
non-cash interest expense associated with warrants issued to SVB, $88,000
related to interest on Xchanges bank line of credit, $1,056,000 in non-cash
interest related to the accretion of discounts on convertible debetures,
$528,000 in non-cash interest related to the convertible debentures, offset by
$30,000 of interest income. Interest expense, net in Q3 2002 was comprised
primarily of $2,046,000 in non-cash interest related to the accretion of
discounts on convertible debentures, $922,000 in non-cash interest related to
the convertible debentures, $63,000 in interest payable on convertible notes
payable on certain former shareholders of CA, $103,000 related to interest on
Xchanges bank line of credit and $7,000 interest on capital leases and other
lease obligations, offset by $10,000 of interest income.

Nine Months Ended September 30, 2001 and 2002

Revenues

Xchange s total revenues decreased 56.8% from $35.7 million in the nine
months ended September 30, 2001 to $15.4 million for the nine months ended
September 30,2002. Software license fees decreased by $11.6 million, or 67.0%,
from $17.3 million in the nine months ended September 30, 2001 to $5.7 million
in the nine months ended September 30, 2002. Included in software license fee
revenue in the nine months ended September 30, 2001 was $8.2 million from
Carreker related to guaranteed royalties on sales of the EnAct product. In Q4
2001, Xchange decided to discontinue the sales and support of the EnAct product
and sold the EnAct technology to Carreker, therefore there was no comparable
EnAct royalty revenue in the nine months ended September 30, 2002. The
remaining decrease is attributed primarily to fewer sales resulting from a
general market slowdown in information technology spending.

Services and maintenance revenues decreased by $8.7 million, or 47.2%,
from $18.4 million in the nine months ending September 30, 2001 to $9.7 million
in the nine months ended September 30, 2002. The decrease is attributed to
decreases in services engagement revenue of $5.0 million, eMessaging ASP
revenue of $1.2 million and maintenance revenue of $2.5 million. The decrease
in services engagement revenue is due partially to the reduction in software
license fees revenue, resulting in reduced software implementation and
integration services. The decrease in eMessaging ASP revenue reflects the
growing competition for these services due to excess eMessaging capacity in the
marketplace. The decrease in maintenance reflects the decrease in Xchanges
base of customers due to customers electing to not renew annual maintenance.

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Cost of Revenues

Cost of software license fees consists primarily of royalty payments made
to third-parties for licensed intellectual property included in Xchange
software products, and cost associated with software packaging and
distribution. The cost of software license fees decreased in absolute dollars
from $549,000 in the nine months ended September 30, 2001 to $205,000 in the
nine months ended September 30, 2002. The decrease in absolute dollars of the
cost of software license fees is due to a decrease in the third-party royalties
for components of the Xchange 8.0 product suite.

Cost of services and maintenance consists primarily of personnel,
facilities and system costs incurred in providing professional consulting
services, training, hosting software services for the Xchange eMessaging
software product, and customer support services. Cost of services and
maintenance as a percentage of services and maintenance revenue was 66.9% in
the nine months ended September 30, 2001 and 40.0% in the nine months ended
September 30, 2002. The decrease in cost of services and maintenance in both
absolute dollars and a percentage of services and maintenance revenues is due
primarily to corrective actions Xchange took throughout the later half of 2001
and into Q3 of 2002 designed to adjust its infrastructure cost downward to
better match the lower anticipated level of revenues.

Overall gross profit percentage improved from 64.0% in the nine months
ended September 30, 2001 to 73.5% in the nine months ended September 30, 2002,
as a result of Xchanges costs containment and restructuring efforts.

Operating Expenses

Sales and marketing expense consists primarily of employee salaries and
benefits for sales and marketing personnel, commissions and promotional
expenses. Sales and marketing expense decreased by $18.9 million, or 75.4%,
from $25.0 million in the nine months ended September 30, 2001 to $6.1 million
in the nine months ended September 30, 2002. Sales and marketing expenses
decreased as a percentage of revenue from 70.2% in the nine months ended
September 30, 2001 to 39.9% in the nine months ended September 30, 2002. The
decrease is due to Xchanges corrective actions in the later half of 2001 and
into Q3 of 2002 designed to adjust its infrastructure costs downward to better
match the lower anticipated revenues.

Research and development expense consists primarily of employee salary and
benefits, consultant costs and equipment and software maintenance costs
associated with new product development, enhancement of existing products and
quality assurance activities. Research and development costs decreased by $8.6
million, or 58.7% from $14.6 million in the nine months ended September 30,
2001 to $6.0 million in the nine months ended September 30, 2002. Research and
development costs as a percentage of revenue decreased from 41.0% in the nine
months ended September 30, 2001 to 39.3% in the nine months ended September 30,
2002. The decrease in both absolute dollars and as a percentage of revenue is
the result of corrective actions Xchange took in the latter part of 2001 and
into Q3 2002 to reprioritize its investments and commitment to existing and new
product offerings and features given its reduced revenue base and need to
conserve cash.

General and administrative expense consists primarily of employee salaries
and related costs, outside professional fees, provision for uncollectible
accounts receivable and equipment and software depreciation cost associated
with the finance, legal, human resources, information systems and executive
functions of Xchange. General and administrative expenses decreased $8.2
million, or 58.6%, from $14.0 million in the nine months ended September 30,
2001 to $5.8 million in the nine months ended September 30, 2002. The decrease
is the result of corrective actions Xchange took in the later part of 2001 and
into Q3 of 2002 designed to reduce general and administrative expenses in line
with the overall reduced infrastructure needs of Xchange and the need to
conserve cash.

Interest income (expense), net

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Interest expense, net in the nine months ended September 30, 2001 was
comprised of $682,000 of non-cash interest expense associated with the
MicroStrategy obligation, $1,919,000 of non-cash interest associated with the
amortization of discounts of the issuance of $4.5 million of convertible notes
and warrants to Insight, $191,000 in interest payable on convertible notes
payable to certain former shareholders of CA, $266,000 in interest on capital
leases and other lease obligations, $47,000 non-cash interest expense
associated with warrants issued to SVB, $162,000 related to interest on
Xchanges bank line of credit, $1,056,000 in non-cash interest related to the
accretion of discounts on convertible debetures, $528,000 in non-cash interest
related to the convertible debentures, offset by $116,000 of interest income.
Interest expense, net in the nine months ended September 30, 2002 was comprised
primarily of $6,071,000 in non-cash interest related to the accretion of
discounts on convertible debentures, $3,238,000 in non-cash interest related to
the convertible debentures, $60,000 of non-cash interest related to warrants
issued to SVB, $191,000 in interest payable on convertible notes payable on
certain former shareholders of CA, $250,000 related to interest on Xchanges
bank line of credit and $23,000 interest on capital leases and other lease
obligations, offset by $35,000 of interest income.

Liquidity and Capital Resources

Since inception, Xchange has financed its operations primarily through
the sale of equity securities in private placements, the issuance of notes
payable to related parties, the issuance of convertible debentures and the
sales of common stock as part of its initial public stock offering in December
1998 and its follow-on public stock offering in June 1999.

Xchange has sustained net losses and negative cash flows from operations
in 2000 and 2001 and the nine months ended September 30, 2002. In addition, as
of September 30, 2002 Xchange has a significant working capital deficit.
Certain other notes payable were due in June 2002 and remained unpaid as of
this filing. Xchanges ability to meet its obligations in the ordinary course
of business and to continue as a going concern is dependent on its ability to
reduce net operating expenses and refinance its existing obligations, or raise
additional financing through public or private equity financing or other
sources of financing. There is no assurance that Xchange will be successful in
its efforts to renew its credit facility, raise additional capital, renegotiate
its existing obligations or to sufficiently reduce it operating expenses, all
of which may have a material adverse impact on Xchanges solvency. These
factors raise substantial doubt about Xchanges ability to continue as a going
concern. The financial statements do not include any adjustments that might
result in the event of the occurrence of this uncertainty.

For the nine months ended September 30, 2002, net cash used in operating
activities was $5.5 million, resulting primarily from a loss of $18.3 million
before depreciation expense and other non-cash charges and an increase in
working capital of $489,000.

Net cash used by financing activities of $7,000 was comprised of net
borrowings against the SVB line of credit of $1.2 million and payments for
capital leases of $1.2 million.

On May 3, 2002 Xchange announced it had received a preliminary offer from
a group led by Insight to acquire Xchange. The offer is non-binding and subject
to customary conditions, including the execution of definitive agreements.
Xchanges Board of Directors has formed a Special Independent Committee to
evaluate the offer.

On May 3, 2002, Xchange restructured its credit facilities with Silicon
Valley Bank (SVB).

Xchanges existing credit facility was modified to provide for advances of
up to $4.0 million on a revolving basis (the Guarantied Line). Xchanges
ability to obtain advances is conditioned upon the absence of any Defaults
or Events of Default (as defined in the loan documentation). The Guarantied
Line is secured by a lien on all of Xchanges assets and is guaranteed (the
Insight Guaranty) by Insight Venture Partners (Insight). SVB required the
Insight Guaranty in order to provide the Guarantied Line. Advances under the
Guarantied Line bear interest at SVBs prime rate plus 0.50% per annum and
mature on May 3, 2003. In consideration for Insight agreeing to provide the
Insight Guaranty, Xchange entered into a Securities Purchase Agreement, dated
as of May 3,
2002, with Insight, pursuant to which Xchange has issued to Insight promissory
notes (collectively, the Insight Note) that will evidence the obligations of
Xchange to reimburse Insight in the event that Insight is

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required to make any payments to SVB under the Insight Guaranty. The Insight
Note bears interest on the unpaid amount thereof at a rate of 2% per month (3%
per month after default) and is payable within 30 days after any
payment is made by Insight under the Insight Guaranty. In addition, in
consideration for Insight agreeing to provide the Insight Guaranty, Xchange
issued to Insight a Contingent Value Right (the CVR). Under the terms of the
CVR, Insight may request that Xchange redeem the CVR for a cash payment equal
to the CVR Value based on the occurrence of a Trigger Event. Trigger
Events include: (a) a sale of Xchange (as defined therein); (b) Xchange
achieving trailing 12 month consolidated revenues in excess of $50 million (the
Revenue Target), or (c) Xchange achieving trailing 12 month consolidated
earnings before interest, taxes, depreciation and amortization expense in
excess of $10.0 million. The CVR Value upon the occurrence of a Trigger Event
will be $3.0 million, except that if the event giving rise to the Trigger Event
is the achievement of the Revenue Target, the CVR Value will be the greater of
$3.0 million and 7% of Xchanges consolidated revenues (not to exceed $10.0
million).

On September 16, 2002, the terms of the Guarantied Line were modified to
allow for advances of up to $5.5 million in the aggregate at any time
outstanding. As a condition to the increase in the Guaranteed Line, the
Insight Guaranty was amended and restated to increase the maximum amount
guaranteed thereunder to $5.5 million.

An additional accounts receivables financing facility was also established
on May 3, 2002 (the Receivables Line). The Receivables Line provided for
advances of up to $4.0 million and matures on May 3, 2003. Under the terms of
the Receivables Line, SVB may, in its sole discretion, make advances to Xchange
based upon a percentage, determined by SVB, of the face amount of Xchanges
accounts receivables that satisfy certain criteria, provided that
no Events of Default (as in the loan documentation) exist. The Receivables
Line is secured by a lien on all of Xchanges assets, but is not guaranteed by
Insight. Advances under the Receivables Line bear interest at
SVBs prime rate plus 2.50% per annum.

On August 15, 2002, the terms of the Receivables Line were amended to
reduce the maximum amount available thereunder from $4.0 million to $1.5
million.

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ITEM 3. Quantitative and Qualitative Disclosure about Market Risk

The following discussion about Xchanges market risk disclosures involves
forward looking statements. Actual results could differ materially from those
projected in the forward-looking statements. Xchange is exposed to market risk
related to changes in interest rates and foreign currency exchange rates.
Xchange does not use derivative financial instruments for speculative or
trading purposes.

Interest Rate Sensitivity.Xchange maintains a short-term investment
portfolio consisting mainly of corporate debt securities and U.S. government
agency treasury bills and notes with an average maturity of less then twelve
months. These available-for-sale securities are subject to interest rate risk
and will fall in value if market interest rates increase. If market interest
rates were to increase immediately and uniformly by 10 percent from levels at
September 30, 2002, the fair value of the portfolio would decline by an
immaterial amount.

Foreign Currency Exchange Risk.With sales and services offices in the
United States, United Kingdom and Australia, and a global customer base,
Xchange faces exposure to adverse movements in foreign currency exchange rates.
These exposures may change over time as business practices evolve and could
have a material adverse impact on Xchanges financial results. Historically
Xchanges primary exposure has been nondollar-denominated operating expenses
and sales by its United Kingdom subsidiary. The introduction of the Euro as a
common currency for members of the European Monetary Union, of which the United
Kingdom is not a member, occurred in January 2000. To date, we have not noticed
any material impact from the introduction of the Euro. Xchange is prepared to
hedge against fluctuations in the British Sterling, Euro, or other foreign
currency if the exposure becomes material. As of September 30, 2002 Xchanges
material nondollar-denominated assets and liabilities primarily consisted of
cash, accounts receivable, and accounts payable denominated in British Sterling
and Australian dollars.

Xchange currently has sales offices in the United Kingdom and Australia,
in addition to the United States. Xchanges revenues from international
operations have been denominated in foreign currencies which historically have
been stable in relation to U.S. dollars. As a result, the gain or loss from
foreign currency transactions has not been material to its operating results.
As of September 30, 2002, the material assets and liabilities denominated in
foreign currencies include accounts receivable, accounts payable and cash and
cash equivalents. Due to the stability of the foreign economies where these
assets and liabilities are denominated, Xchange has not adopted a policy of
hedging foreign currency risks. While it is anticipated that foreign
transactions will continue to be denominated in local currencies, Xchange
expects to use hedging instruments to offset potential currency exposures
arising as its international operations expand into less stable economic
environments.




ITEM 4. Controls and Procedures

(a)  Evaluation of disclosure controls and procedures.Based on his
evaluation as of a date within 90 days prior to the filing date of this
Quarterly Report on Form 10-Q, our principal executive officer and principal
financial officer has concluded that our disclosure controls and procedures (as
defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of
1934) are effective to ensure that information required to be disclosed by us
in reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in
Securities and Exchange Commission rules and forms.

(b) Changes in internal controls. There were no significant changes in
our internal controls or in other factors that could significantly affect these
controls subsequent to the date of their evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

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Part II  Other Information




Item 1. Legal Proceedings

From time to time, Xchange is involved in litigation relating to claims
arising out of its operations in the normal course of business. As of the date
of this filing, management believes that it has adequate coverage under its
Directors and Officers and Errors and Omissions insurance policies such that it
is managements opinion that Xchange is not a party to any legal proceedings
that, if decided adversely to Xchange, would have a material adverse effect on
its results of operations or financial position.

Xchange and certain of its current and former officers and its former
certified public accountants, Arthur Andersen, LLP, have been named defendants
in a consolidated class action lawsuit originally filed on February 21, 2001
and subsequently filed as a Consolidated Amended Class Action Complaint on
August 3, 2001, filed on behalf of a purported class of purchasers of Xchanges
common stock during the period from December 9, 1998 through September 29,
2000. The Amended Class Action Complaint alleges that Xchange made false or
misleading statements that inflated its common stock price during the class
period. The relief sought is damages on behalf of the class; however, at this
time, Xchange is unable to ascertain the monetary damages sought by the class.
Through its attorneys, Xchange has filed a Motion to Dismiss the Amended Class
Action Complaint on October 3, 2001. The action is pending in the United States
District Court for the District of Massachusetts. Xchange believes these
allegations are without merit and intends to continue to defend the litigation
vigorously.

Xchange, certain of its current and former officers and directors,
including Andrew J. Frawley, John G. OBrien, Jeffrey Horing, Ramanan
Raghavendran, David G. Mcfarlane, Michael D. McGonagle, Patrick A. Mchugh, and
N. Wayne Townsend, and the Underwriter Defendants (as defined herein) have
purportedly been named defendants in a class action complaint filed on behalf
of a class of purchasers of its common stock during the period from December 9,
1998 through December 6, 2000. The Underwriter Defendants are BT Alex Brown,
Inc., Hambrecht & Quist, LLC, Adams, Harkness & Hill, Inc., and Sound-View
Technology Group, Inc. Xchange has not yet been served with this complaint, but
it purportedly alleges that documents filed in connection with Xchanges
initial and follow-on public offerings (the Offerings) were materially false
and misleading because they failed to disclose that (1) the Underwriter
Defendants solicited and received excessive and undisclosed commissions from
certain investors in exchange for which the Underwriter Defendants allocated to
those investors material portions of the restricted stock issued in connection
with the Offerings, and (2) the Underwriter Defendants had entered into
agreements with customers whereby they agreed to allocate Xchanges shares to
those customers in the Offerings in exchange for which the customers agreed to
purchase additional shares in the after-market at pre-determined prices. At
this time, Xchange is unable to ascertain the monetary damages sought by the
class. The action is pending in the United States District Court for the
Southern District of New York. Xchange believes these allegations are without
merit and intends to defend the litigation vigorously.




Item 3.Defaults Upon Subordinated Notes

Xchange is in default on certain notes payable that had been entered into
as part of the June, 2000 CA acquisition. These notes, which have an aggregate
principal balance of approximately $2.5 million, matured on June 1, 2002;
however, the various noteholders have entered into subordination agreements
with SVB (the Subordination Agreements). Pursuant to the Subordination
Agreements, Xchange is restricted from making any payments to these
noteholders, and the noteholders are restricted from demanding any such
payment, until the SVB debt is paid in full. The note holders have
acknowledged the existing conditions and payment arrangements of the
subordination agreements.

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Item 4.Submission of Matters to a Vote of Security Holders

None.




Item 6. Exhibits and Reports on Form 8-K.

(a) Exhibits

|       |  |                                                                                                                                                                                                                             
|------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.01* |  | Amendment No. 1 to warrants to purchase stock, dated May 3, 2002,
between Xchange and Silicon Valley Bank (SVB) (Incorporated by
reference from Exhibit 10.28 to Xchanges Annual Report on Form
10-K, filed May 14, 2002)
|      
|      
|      
|      
|       |  |                                                                                                                                                                                                                             
|      
|      
|      
|      
|99.01* |  | Amended and Restated Loan and Securities Agreement, dated May 3,
2002, between Xchange and SVB. (Incorporated by reference from
Exhibit 99.11 to Xchanges Annual Report on Form 10-K, filed May
14, 2002)                  
|      
|      
|      
|      
|       |  |                                                                                                                                                                                                                             
|      
|      
|      
|      
|99.02* |  | Form of Accounts Receivable Financing Agreement, dated May 3, 2002,
between Xchange and SVB. (Incorporated by reference from Exhibit
99.12 to Xchanges Annual Report on Form 10-K, filed May 14, 2002)                     
|      
|      
|      
|      
|       |  |                                                                                                                                                                                                                             
|      
|      
|      
|      
|99.03* |  | Form of Security Agreement, dated May 3, 2002, between Xchange and
Insight. (Incorporated by reference from Exhibit 99.13 to Xchanges
Annual Report on Form 10-K, filed May 14, 2002)                                      
|      
|      
|      
|      
|       |  |                                                                                                                                                                                                                             
|      
|      
|      
|      
|99.04* |  | Form of Senior Secured Note, dated May 3, 2002 between Xchange and
Insight. (Incorporated by reference from Exhibit 99.14 to Xchanges
Annual Report on Form 10-K, filed May 14, 2002)                                      
|      
|      
|      
|      
|       |  |                                                                                                                                                                                                                             
|      
|      
|      
|      
|99.05* |  | Form of Contingent Value Right, dated May 3, 2002, between Xchange
and Insight. (Incorporated by reference from Exhibit 99.15 to
Xchanges Annual Report on Form 10-K, filed May 14, 2002)                                  
|      
|      
|      
|      
|       |  |                                                                                                                                                                                                                             
|      
|      
|      
|      
|99.06* |  | Form of Securities Purchase Agreement, dated May 3, 2002, between
Xchange and Insight. (Incorporated by reference from Exhibit 99.16
to Xchanges Annual Report on Form 10-K, filed May 14, 2002)                           
|      
|      
|      
|      
|       |  |                                                                                                                                                                                                                             
|      
|      
|      
|      
|99.07* |  | First Amendment to Accounts Receivable Financing Agreement, dated
August 15, 2002, between Xchange and SVB. (Incorporated by
reference from Exhibit 99.07 to Xchanges Quarterly Report on Form
10-Q, filed August 8, 2002.)
|      
|      
|      
|      
|       |  |                                                                                                                                                                                                                             
|      
|      
|      
|      
|99.08  |  | Certification of Principal Executive Officer and Principal Finance
and Accounting Officer Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                          

*     Incorporated by reference

(b)  Reports on Form 8-K
Report on Form 8-K filed with the SEC on August 7, 2002.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

|                  |  |                                                                                                        
|----------------- |  | -------------------------------------------------------------------------------------------------------
|November 14, 2002 |  | EXCHANGE APPLICATIONS, INC.
(Registrant)                                                               
|                 
|                 
|                 
|                 
|                  |  | /s/ J. Christopher Wagner                                                                              
|                  |  |                                                                                                        
|                  |  | J. Christopher Wagner
President, Chief Executive Officer
and Principal Financial and Accounting
Officer




CERTIFICATIONS

I, J. Christopher Wagner, certify that:

1.     I have reviewed this quarterly report on Form 10-Q of Exchange
Applications, Inc.;

2.     Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

3.     Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

4.     The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a) Designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;

b) Evaluated the effectiveness of the registrants disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and

c) Presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;

5.     The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent functions):

a) All significant deficiencies in the design or operation of internal controls
which could adversely affect the registrants ability to record, process,
summarize and report financial data and have identified for the registrants
auditors any material weaknesses in internal controls; and

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b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal controls;
and

6.     The registrants other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

|                         |  |                                                                                                         
|------------------------ |  | --------------------------------------------------------------------------------------------------------
|Dated: November 14, 2002 |  | /s/ J. Christopher Wagner                                                                               
|                         |  |                                                                                                         
|                         |  | J. Christopher Wagner
President, Chief Executive Officer,
and Principal Financial and Accounting
Officer

23